Rateworks auto loan refinance
June 19, 2024

When Should You Use an Auto Equity Loan?

An auto equity loan can be a valuable financial tool, but it's crucial to understand when it's the right option for your needs.

What is an auto equity loan?
Written by

Jennifer Moore

Every day, consumers take out various loans to help pay for large purchases. Whether it be a mortgage for a new home, a student loan to pay for education, an auto loan to buy a vehicle, or a personal loan to cover another type of expense—lending and borrowing help us to obtain those things.

One ever-popular loan option is the home equity loan. This type of loan allows the borrower to borrow against the value of their home literally. Home equity loans are perfect for families who want to make some home improvements, add landscaping, refinance a vehicle, or even take a dream vacation. But home equity loans aren’t the only type of equity loans available—there are auto equity loans, too. 

How do you apply for an auto equity loan?

What is an Auto Equity Loan?

It’s probably relatively obvious about the benefits of a home equity loan. With the average home price in the U.S. around $495,100, there can be some sizeable equity in that home over the years. It takes about five years to grow that equity, and once it is there, you can often borrow against is for sizeable financial needs.

But what about an auto equity loan? Car values are significantly lower than home values. For comparison, consider that the average new car price is currently hovering around $47,244. And, we all know that cars tend to lose value the moment they are purchased and driven off the sales lot. 

Auto equity loans allow car owners to use the value of their vehicle as collateral for a loan. This means if you own a car with value, you may be able to borrow money against it. Here's a breakdown of how auto equity loans work:

  • Determining Value: The amount of money you can borrow with an auto equity loan depends on your car's value. Lenders usually use the wholesale value of the car to determine how much equity you have. They might also consider factors like the make, model, year, mileage, and overall vehicle condition.
  • Loan Structure: Typically, auto equity loans are short-term loans. This means they often have a payback period ranging from a few months to a few years. Considering this short repayment schedule is important because it can affect how manageable your monthly payments will be.
  • Interest Rates: The interest rates for auto equity loans vary widely and are often higher than traditional bank loans. This is because auto equity loans are considered higher risk due to cars' depreciating value. Lenders charge higher rates to offset this risk.

Factors Impacting the Loan

As with any loan, certain factors determine the rate and terms you will get. Consider the following:

  • Credit History/Score: Your credit score plays a significant role in determining the terms of your loan. A higher credit score might help you secure a lower interest rate, while a lower score could result in a higher rate.
  • Repayment Term: The loan length affects your monthly payments and the total interest you'll pay. Shorter terms mean higher monthly payments but less interest overall, whereas longer terms spread the payments but increase the total interest.

Considering these factors, auto equity loans can be a useful financial tool, but they require careful consideration of the terms and your ability to repay the loan. 

What types of interest rates are usually offered for auto equity loans?

When Should You Use an Auto Equity Loan?

This all begs the question—when should you use an auto equity loan? And as with any type of loan you consider, it all starts with ensuring that you have a need for the funds and that you have the means to fulfill your end of the deal, all of which will be laid out in your loan agreement.

For example, if you are thinking of taking out an auto equity loan for a dream vacation, consider if now is the best time to take that vacation, especially if money is tight. Consider if you have the funds to make your payments. Think about what might happen if you take that vacation and then experience some sort of emergency that keeps you from making your payments on time. That could have some fire consequences on your credit score and financial future.

So, just when should you use an auto equity loan? The team at RateWorks suggests the following:

Financial Emergencies That Require Significant Cash Up-Front

Auto equity loans can be a viable solution during financial emergencies that require significant cash immediately, such as unexpected medical bills, urgent home repairs, or legal expenses. These loans provide quick access to funds, allowing you to address pressing needs without the lengthy approval processes often associated with other types of loans.

To Increase Cash Fluidity in Short Term

Using an auto equity loan can temporarily boost your cash flow. This can be particularly helpful for covering short-term financial gaps, like bridging the time between jobs or managing unexpected expenses while waiting for other funds to become available. It's a strategic option to maintain financial stability without committing to long-term debt.

When You Have Significant Equity in Your Car/Won't Overleverage Yourself

An auto equity loan is advisable if you have significant equity in your car and the loan does not jeopardize your financial health. This means the loan amount should be manageable within your budget, ensuring you can maintain payments without overleveraging yourself. It’s a practical option if you can borrow against your car while keeping your financial obligations in check.

Questions to Ask Yourself Before Taking Out an Auto Equity Loan

Like we said, before taking out any loan, you must do your homework to not only find the best loan for your needs but to ensure that you can hold up your end of the bargain. Here are some things to remember and questions to ask yourself. 

  • Is there enough equity to justify the potential interest costs? Calculate the equity in your vehicle compared to the loan amount you need. Ensure that the cost of the loan, including interest, does not surpass the benefit you'll gain from the borrowed funds.
  • Do you have a repayment plan? Always have a clear and feasible plan for repaying the loan. Consider your income stability and whether you have contingencies in place should your financial situation change.
  • Have you considered the risk of accidents/mechanical failures that damage equity? Your car serves as collateral; any damage could reduce its value and your equity in it. Consider the implications if the car is damaged and loses value.
  • Is refinancing your auto loan a better option? If your goal is to save money on payments over a longer term or reduce your monthly expenditure, applying for auto loan refinancing might be a more suitable choice than an auto equity loan. Refinancing could offer lower interest rates or extended repayment terms without the added risk of losing your vehicle.

Consider Auto Refinancing with RateWorks

Auto equity loans are a great option for those wishing to fund sizeable car repairs or offset a purchase. However, if your goal is to save money each month, you might benefit from refinancing your car. You may be able to save on interest, but more importantly, you can spread your car payments out further into the future, thus lowering your monthly payment to one that is easier for you to manage.

Want to learn more? Check out our auto refinance calculator and get a free quote today.